RISK ASSESSMENT

Growth slows towards potential

The renewed strength of the economy in 2017/18 is expected to fade in 2019 as growth starts moving towards its potential level. Reduced pressure on the labour market (thanks to a slight increase in immigration and a fall in employment) and low productivity growth, in the absence of structural reforms, should moderate wage growth and, therefore, private consumption, which is the main contributor to growth (two thirds of GDP). Tax reforms, which will introduce a progressive taxation system, are expected to favour the poorest households, which, thanks to their higher marginal propensity to consume, should mitigate the deceleration in consumption. The level of wages, particularly the minimum wage, will nevertheless remain quite high relative to productivity, which will negatively impact the competitiveness of companies, hurting export performance. Rising international trade tensions could also have an adverse effect on exports (80% of GDP), causing trade to make a negative contribution to trade. Investment (almost 20% of GDP), which has grown briskly in recent years thanks to businesses and easy access to credit, is therefore also expected to slow down. Lower business confidence, difficulties in finding skilled workers, the large informal component of some sectors and the prospect of moderate growth, in the context of international tensions, are all factors that may also explain this deceleration, which should nevertheless be mitigated by better use of EU funds directed towards construction and civil engineering. Public expenditure is expected to change little and to have a relatively small direct impact on growth. Even so, this spending, which will be aimed at reducing inequalities and boosting productivity, should make a positive contribution through private consumption.

Small current account deficit and government surplus

According to the approved budget, the central government deficit is forecast to be 0.4% of GDP. Revenues are expected to jump by 17%, thanks in particular to European structural and investment funds, which are set to increase from 0.6% of GDP in 2017 to 2% in 2019. However, they will be outpaced by expenditure, which is expected to go up by 22%. Spending will mainly be directed towards education, social security, healthcare and a pension reform in order to reduce inequalities and improve labour productivity, with the aim of building the “new social model” recommended by international institutions to unleash growth. Tax reforms, advocating a shift in employer contributions to employees (which would be offset by higher wages) and increasing the minimum level of taxable income, also have this goal in mind. If the balance of municipalities and the social security system is added, the government deficit should turn into a surplus. The stated objective is to accumulate reserves (up to €1.5 billion in 2019) and reduce public debt, of which 80% is held by non-residents and almost 30% is denominated in foreign currency.

In 2019, the current account is expected to turn slightly into a deficit. Sluggish demand from the EU, increased domestic demand, which favours imports, and the fall in Russian imports, which considerably reduces re-exports, will worsen the goods deficit. The overall trade surplus (2.3% in 2017) – generated by the high level of exports of services, particularly in tourism and road transport – is therefore expected to decline. Transfers (1.8% of GDP), mainly composed of remittances from expatriates and European funds, despite holding steady, are not expected to offset the income deficit (3.3%), which is explained by the high stock of FDI in the country (43% of GDP). These investments are expected to grow by almost 2% of GDP in 2019, a level equivalent to the Lithuanian portfolio investment abroad. The size of Lithuania’s gross external debt (81.6% of GDP at the end of June 2018) needs to be considered in the light of the debt’s composition – state (37%), central bank (28%), banks (14%) and non-financial companies (21%) –, the assets held abroad by the country (63% of GDP) and the fact that the debt is denominated in euros.

A year of elections to dispel political uncertainty

The country has been ruled since 2016 by Prime Minister Saulius Skvernelis, who is affiliated with the centrist LVZS Party, which unexpectedly won the 2016 parliamentary elections. Despite his minority (56 seats out of 141 in Parliament), he was able to gain power by forming an alliance with the LSDP, which has 17 seats. Since then, the LSDP has withdrawn from the coalition, although its ministers remain in government. The potential instability created by this situation is tempered by the consensus in local political life on the desire for reform, in particular to support the new social model. The presidential elections, which will take place in May 2019 – together with European elections, and a referendum to allow dual citizenship, in order to compensate for demographic deficiencies that are damaging the economy – will be a good gauge of popular support for the current government and for tax reform. In addition, the country joined the OECD in May 2018, confirming its good economic situation, which is likewise borne out by its position (14th) in the Doing Business 2019 ranking.